Why do oil and gas companies hedge?

Hedging oil and gas production for months or even years into the future is a vital tool for companies to provide certainty to their cash flow statements, by potentially securing future revenues for a specific, pre-determined period of time. Indeed, for some companies an effective hedging strategy is often the difference between success and failure. Canada's oil and gas hedging market is now covered comprehensively, down to a single contract level, by CanOils. Find out more here.

While entering into a hedging contract means that producers forgo the benefits of any significant commodity price increase, the company is simultaneously protected against a dramatic decline in prices.

Some companies may value this cash flow certainty over the potential upside at any given time for many different reasons. For example, there may be companies that have huge capital expenditure plans to create significant production growth for the next few years, and while the upside of a short-term price increase is appealing, it is not worth jeopardising any growth plans should prices actually decline. So these companies may elect to take out a hedging contract to ensure its budget is safe for the future of the company.

Some companies may just want to keep dividend payments stable in difficult times to avoid losing investors, while others could be at or close to their break even already in terms of commodity prices. Agreeing hedging deals would help to ensure the company stays afloat through a difficult period and is protected against any further fall in prices.

There may also be companies that are in a position where external finance (e.g. raising cash by securing new debt or issuing new shares) may be unavailable, unwanted or hard to come by; hedging contracts can act as an alternative funding guarantee.

Of course, not all companies take this approach at all for various reasons; indeed, some of even the TSX's largest producers including Suncor Energy Inc. and Husky Energy Inc. do not hedge. But for those that do, it is possible to partly decipher each company's attitude to price risk through their own hedging contract portfolio.

Every TSX and TSX-V-listed company's outstanding hedging contracts active in 2017, 2018 and even 2019 is available in the new and improved CanOils hedging module. For more information on the module and the data provided, click here.

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